Public officials of financially strapped states like California, Florida, Nevada, Ohio, Wisconsin and Michigan are outraged at New York-based securities firm Goldman Sachs for advising some of its biggest institutional clients to bet against state municipal bonds by purchasing credit default swaps. Meanwhile, Goldman has collected millions of dollars in fees to help those states sell some of the very same bonds.
According to a Dec. 10 story by Bloomberg, in the three months since Goldman recommended shorting municipal credit, the value of the Markit MCDX index of the derivatives’ price more than tripled – from 87.75 to as high as 278.33 basis points.
Goldman’s strategy of shorting municipal bonds of fiscally depressed states could ultimately result in even more problems for taxpayers. Concerns about a state’s credit quality often means bond prices go down. In turn, that can drive up the interest rate states and municipalities must pay to borrow money. And it all affects taxpayers. An increase of one percentage point on a $1 billion bond issue translates into a cost to taxpayers of an additional $10 million a year in interest.
The added financial worries couldn’t come at a worst time. States, which already have closed $40 billion in fiscal year 2009 budget gaps, face at least an additional $97 billion that they must close over the next 18 to 24 months, according to a just-released national report by the National Conference of State Legislatures.
In a September presentation to institutional investors on “Best Long and Short Risk Strategies,” Goldman apparently advised buying credit-default swaps on “a basket of liquid State General Obligation credits with current and worsening fiscal outlooks, according to the Bloomberg article. The firm went on to recommend the derivatives in states with heavily unfunded pensions and other retiree obligations.
Goldman is one of the top five municipal bond underwriters in the United States. Its latest trading strategy of betting against its own clients is a bad way to conduct business – period. In this case, Goldman is baking its cake and eating it, too, while states in which Goldman served as the underwriter of their securities can look forward to an even more troubled fiscal outlook in the months ahead.
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